Publication: Persistent markups in bidding markets with financial constraints
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2011-10-26
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Abstract
This paper studies the impact of financial constraints on the persistency of high
markups in a class of markets, including public procurement, known by practitioners as
bidding markets. We develop an infinite horizon model in which two firms optimally
reinvest working capital and bid for a procurement contract each period. Working capital
is constrained by the firm's cash from previous period and some exogenous cash flow, it
is costly and it increases the set of acceptable bids. We argue that the latter is a natural
consequence of the presence of progress payments or the existence of moral hazard. We
say that the firm is (severely) financially constrained if its working capital is such that only
bids (substantially) above production cost are acceptable. We show that markups are
positive (high) if and only if one firm is (severely) financially constrained. Our main result
is that markups are persistently high because one firm is severely financially constrained
most of the time.
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Bidding markets, Financial constraints, Markups